HSBC’s risk aversion warning highlights challenge facing Auditors

Bank Chairmen tend to be diplomatic people, so recent comments made by Douglas Flint, HSBC’s Chairman, are truly remarkable.

The nub of his remarks was that there is “an observable and growing danger of disproportionate risk aversion creeping into decision making in our business as individuals, facing uncertainty as to what may be criticised with hindsight and receiving a zero tolerance of error, seek to protect themselves and the firm from future censure”.

In other words, bankers are becoming paralysed by fear that if they take a risk, any risk, which goes wrong (and it is the nature of risks that some will) they will be criticised, pilloried, fired or even, under current proposals, jailed. As if this wasn’t enough, he also laid into the growing chaos of the regulatory regime, as ever-more demands are made on banks by the authorities. It is worth quoting him at some length.

He attacks a “regulatory reform programme that is unfortunately increasingly fragmented, often extra-territorial, still evolving and still adding definition is hugely consumptive of resources that would otherwise be customer facing. Add to this recent obligations to perform highly granular multiple stress tests which are inconsistent in definition and scenarios between major jurisdictions and so require considerable duplication of effort; recently announced significant wholesale market practice and competition reviews in the UK; re-organising the financial, operational and structural framework of the Group to respond to evolving thinking on cross-border resolution protocols; and, finally, planning what will be a multi-year project to separate and establish the ring-fenced bank in the UK, and the dimension of the execution risk is obvious”.

It is clear that banks are facing unprecedented challenges. Indeed, if the behemoth that is HSBC is having resource problems in dealing with the avalanche of new laws, regulations and requirements, how much harder must it be for banks that lack HSBC’s scale?

The audit function, of course, is right in the front line of all this. Not only must it undertake its usual duties of assessment, oversight and reporting, it must face the additional burdens of ensuring that all departments are aware of the new regimes, and are meeting their requirements. As these are extremely complex, and are changing rapidly, it is a huge ask for both auditors and those they are auditing to keep up to date, and ensure that the requirements are met. This is important in any circumstances, but when senior managers could be imprisoned for not meeting regulatory demands, and when ignorance will not be allowed as an excuse, it becomes even more vital.

The only way round the related issues of regulatory overkill and extreme risk aversion is for all relevant staff know exactly what the regulations state, and how they apply to them. Only then can management be in a position to accept risk, and thus generate the returns that pay the staff and reward the shareholders, rather than play safe and simply avoid it. However, keeping up with the regulations, understanding and interpreting them, is a major job, requiring specialist expertise that it is unreasonable to expect audit professionals and line bankers to possess, so the understandable response is to play safe and accept the adverse consequences. If this position becomes the default, risk aversion will slowly but surely strangle the banking industry.

However, a solution does exist. The logical thing for banks to do is to utilise the expertise that exists outside the industry. Here at Skadi, for example, we have the expertise to work closely with the audit function to ensure that all departments are aware of what the regulations involve, and how they will apply to them. Thus armed, and with the confidence that even hostile regulators will be assured that every step has been taken to ensure compliance, management will be able to accept risk in the knowledge that they are not breaching the regulations, rather than simply avoiding risk altogether.

The most successful banks in the coming years will be those which have tailored their businesses to fit the new regulatory regime: those which know exactly what the regulations are, what they mean, and precisely what is involved in meeting them, will have a crucial competitive advantage over those that don’t.